Financial Planning

A few definitions… Personal Financial Planning Process of managing your money to achieve personal economic satisfaction Financial Plan Formalized report that summarizes your current financial situation, analyzes your financial needs, and recommends future financial activities

Inflation A rise in general level of prices The buying power of dollar decreases Most harmful to people with fixed incomes and lenders of money Inflation rates vary : 1-3% inflation annually : 10-12% inflation annually At 12%, prices double in about six years – use Rule of 72 to find when prices double

Consumer Price Index (CPI) Measure of the average change in the prices urban consumers pay for a fixed “basket” of goods and services Computed by Bureau of Labor Statistics More recently, CPI has been in 2-4% range Reported inflation may be much lower than actual cost of living Hidden inflation present since necessities (gas, food, health care, etc.) may rise in price faster than nonessential items

Interest Rates Money ain’t free Paid to you if you give someone money or paid by you if you borrow money Risk – a factor in interest rate of borrower Lower credit ratings = higher risk = higher interest rate

Quick Check For each of the following situations, indicate if the person would tend to “suffer” or tend to “benefit” from inflation. A person with money in a savings account. suffer benefit A person who is borrowing money. suffer benefit A person who is lending money. suffer benefit A person receiving a fixed income amount. suffer benefit

Quick Check For each of the following situations, indicate if the person would tend to “suffer” or tend to “benefit” from inflation. A person with money in a savings account. suffer benefit A person who is borrowing money. suffer benefit A person who is lending money. suffer benefit A person receiving a fixed income amount. suffer benefit

Quick Check For each of the following situations, indicate if the person would tend to “suffer” or tend to “benefit” from inflation. A person with money in a savings account. suffer benefit A person who is borrowing money. suffer benefit A person who is lending money. suffer benefit A person receiving a fixed income amount. suffer benefit

Quick Check For each of the following situations, indicate if the person would tend to “suffer” or tend to “benefit” from inflation. A person with money in a savings account. suffer benefit A person who is borrowing money. suffer benefit A person who is lending money. suffer benefit A person receiving a fixed income amount. suffer benefit

Quick Check For each of the following situations, indicate if the person would tend to “suffer” or tend to “benefit” from inflation. A person with money in a savings account. suffer benefit A person who is borrowing money. suffer benefit A person who is lending money. suffer benefit A person receiving a fixed income amount. suffer benefit

Type of Financial Goals Short-term goals Achieved within the next year or so, such as saving for a vacation or paying off small debts Intermediate goals Time frame of 2-5 years Long-term goals >5 years off, such as retirement, money for children’s college education, or purchase of a vacation home

Goal-Setting Guidelines (SMART approach) S – specific Know exactly what your goals are and quantify as much as possible M – measureable For example, “Accumulate $5,000 by next year” instead of “Save money” A – action-oriented Detail actions necessary to accomplish goal R – realistic Make goals based on your income and life situation T – time-based Give time frame for achieving goal – allows you to measure progress.

Opportunity Cost What a person gives up by making a choice Cost is commonly called a trade-off Typically cannot be measured in dollars

Time Value of Money The increases in an amount of money as a result of interest earned Simple interest calculations: Present value (also called discounting) – the current value of an amount desired in future Future value (also called compounding) – the amount to which current savings will increase based on certain rate and time period Can be calculated with formulas, tables, calculator programs, etc.

Future Value of a Single Amount Example: $650 deposited into 8% APR (risk free) for 10 years

Future Value of an Annuity (Series of Deposits)

Example: Jonie has two children who will start college in 10 years. She plans to set aside $1,500 a year for her children’s college education during that period and estimates she will earn an annual interest rate of 5 percent on her savings. What amount can Jonie expect to have available for her children’s college education when they start college?

Present Value of a Single Amount Example: What is the present value of $1 to be received three years from now based on a 10 percent interest rate?

Present Value of an Annuity (Series of Deposits) Example: What is the present value of a $1 withdrawal at the end of the next three years for money earning 10 percent?